What is the difference between a Part A and Part B SMSF Qualification?

An SMSF must undergo an annual audit whereby the auditor is required to give the SMSF trustee their audit report within 28 days after receiving all necessary documents for the audit, and this must be completed before lodging the annual return. The audit is split into two sections: Part A: The financial audit, and Part B: The compliance audit.

A Part B qualification is generally viewed as more serious than a Part A qualification. A significant breach in Part B can have severe consequences for the fund, whereas a breach in Part A usually only results in the trustee needing to make minor changes to the fund’s operations.

Part A Qualification

An SMSF auditor is governed by Australian Auditing Standards in relation a financial audit. The auditor has to form an opinion whether the financial report is fairly and materially recorded. The financial report of the fund includes the statement of financial position at 30^th June, the operating statement and a summary of significant accounting policies and other explanatory notes.

The SMSF auditor will seek independent third-party evidence to support the assets, liabilities, income and expenses are presented fairly on the fund’s operating statement and the statement of financial position at 30^th June.

Examples when an SMSF auditor may qualify the financial report include:

• unable to verify if an asset exists and is in the name of the SMSF such as property in the title of an SMSF member where the trustee is a corporate trustee, foreign property where the SMSF is unable to own property directly or physical assets such as gold – there may be other evidence that can be provided supporting SMSF ownership
• assets held via an investment platform, managed investment scheme or wrap accounts are not held by the SMSF directly but owned by a custodian and the reconciliation of the underlying investments to an SMSF account is undertaken by the platform administrator – the SMSF auditor would have to audit the accounts of the administrator to verify the existence, market value and title of the investments as well as the income and expenses incurred – the cost of doing this is prohibitive and access to the supporting evidence unavailable
• a fund has a related party loan as part of a limited recourse borrowing arrangement (LRBA) and the interest charged is below the market value – the expense is non-arm’s length expense NALE) resulting in the rental income and disposal of the property being classified as non-arm’s length income (NALI) and potentially taxed at 45% – incorrectly recording the correct tax can lead to a material misstatement of the fund’s tax expense
• the market value and the recoverability of shares held in private unlisted companies, private unit trust or unsecured loans where the evidence supporting the underlying assets and liabilities are not provided to the auditor
• the opening balances in a first-year audit – the ATO recognise this as a minor low risk breach and do not require a trustee to report a Part A breach in its annual return where there are no other Part A breaches

Part A qualification may also trigger a Part B qualification as it may also breach the superannuation laws such as property valued at cost in the statement of financial position instead of market value.

Don’t overreact to a Part A qualification

Rather than being fearful of a Part A qualification take the time to understand what the auditor wants you to correct and how you can prevent this from recurring in the future. A common Part A qualification is not providing sufficient evidence of the market value of rent when the fund’s commercial property is leased to a member of the SMSF or a related company or trust.  Generally, a new market valuation is required at the start of the lease, when the tenant takes up an option to renew a lease or there are other significant changes made to the property.

Part B Qualification

Part B of an SMSF audit report relates to the compliance of the fund with the Superannuation Industry (Supervision) Act 1993 (SIS) and the Superannuation Industry (Supervision) Regulations 1994 (SISR).  An SMSF auditor is required to form an opinion whether an SMSF trustee has complied with specific provisions of SIS and SISR.

Generally, Part B breaches occur in relation to related party transactions which can include:

• sole purpose test – such as making low interest loan to an SMSF member (this will also contravene other provisions of SIS and SISR)
• separation of assets to ensure the personal assets of trustee/directors must not get mixed with fund assets such as a bank account in the name of a member when the fund has a corporate trustee
• prohibition of acquiring new in-house assets or having in-house assets at 30^th June over 5% threshold
• prohibition on acquisitions of assets from related parties or loans to members or their relatives

Other significant compliance breaches include:

• not valuing fund assets at market value
• prohibition on borrowings except in limited circumstances such as having a limited recourse borrowing arrangement (LRBA)

The audit report is not sent to the ATO but is kept with the fund’s records. However, the questions “Was Part B of the audit report qualified?” and “If Part B of the audit report was qualified, have the reported issues been rectified” form part of the fund’s annual return. If the Part B breaches are considered to be material the auditor must report them to the ATO in an auditors contravention report (ACR).

A summary of audit breaches

1. Level 1 – Part A qualification but no Part B or ACR – reported in the SMSF annual return but low risk.
2. Level 2 – Part B qualification but no ACR – reported in the SMSF with a qualifying “has it been rectified” – low to medium risk especially if the breach has been rectified.
3. Level 3 – ACR reported to the ATO – medium to high risk bringing the breaches to the direct attention of the ATO but if rectified quickly and action satisfies the ATO no further action – depends on the qualification and the trustee’s responses which can result in penalties such as administrative penalties (monetary penalties), enforceable undertakings, rectification directions, disqualification of the trustee and being made non-compliant and losing the fund’s tax concessions if the trustee takes no action or the breaches are very serious.

For more information about the SMSF Audit process checkout our Resources page:

SMSF Auditing & The Role of the SMSF Auditor